Fed debates future asset purchases

Members debate what should replace expiring ‘Operation Twist’

WASHINGTON (MarketWatch) — Federal Reserve officials faced off in October about whether the central bank needed to buy more assets once its “Operation Twist” program finishes at the end of the year, according to minutes released Wednesday.

While a “number” of Fed officials, according to the minutes, think the Fed will likely need to buy more assets once its Twist stimulus program wraps up in December, “several” other members questioned whether they were needed.

Others said the asset purchases were making the exit more difficult and a few were worried they presented an upside risk to inflation.

Fed watchers have generally taken it as a given that the Fed would buy more longer-term Treasurys to replace the $45 billion per month under Twist.

“It is pretty clear that [Federal Reserve Chairman Ben] Bernanke has to fight...for more QE and it is not quite as much of a done deal as most believed,” said Alan Ruskin, head of foreign-exchange strategy at Deutsche Bank.

Operation Twist is the nickname of a plan under which the Fed has been selling short-term Treasurys and using the proceeds to buy longer-dated government debt as a way to bring down long-term interest rates.

Even after the minutes, most economists said the Fed would likely decide to buy more assets.

“We continue to expect the $45 billion in long-end Treasury purchases offset by sales of shorter-term Treasuries in Twist to be converted to outright Treasury purchases after year-end,” said Dean Maki, U.S. chief economist at Barclays.

Reuters

U.S. Federal Reserve Chairman Ben Bernanke is seen prior to the International Monetary and Financial Committee at the annual meetings of the IMF and the World Bank Group in Tokyo on Oct. 13, 2012.

In October, the Fed backed continuation of its third round of quantitative easing program to buy $40 billion per month of mortgage-backed securities.

U.S. stocks stumbled to their lowest session of the day after the minutes were released. Traders also were concerned about rising oil prices and a continued impasse in Washington on avoiding the fiscal cliff.Read more Market Snapshot.

Fed close to clearer guidance on first rate hike

According to the minutes, Fed officials moved closer to revamping the central bank’s guidance on what economic conditions would have to be in place before interest rates rise for the first time since the financial crisis.

The minutes of meeting showed that the 19 Fed officials “generally favored” the use of economic variables in their guidance. Read the full minutes.

At the moment, the Fed is relying on a calendar date, saying it expects to keep rates near zero until mid-2015.

The new approach would be some variant of a plan offered by Chicago Fed President Charles Evans, who wants the central bank to tell the market it will keep rates low until the unemployment rate falls below 7%, as long as inflation remains below 3%.

This method got the strong support from Fed Vice Chair Janet Yellen in a speech on Tuesday. Yellen’s backing is seen a critical because she is seen as a leading candidate to replace Bernanke should he decide to leave his post when his term expires in Jan. 2014. Yellen backs new way to give guidance.

The minutes show that a number of practical issues need to be solved before officials would decide to use these “economic thresholds.”

Given the remaining work, Maki said he didn’t think the new thresholds would be ready for approval by the next Fed meeting on Dec. 11 and Dec. 12.

Among the issues still to be decided, whether to use specific numbers for how high inflation would have to rise or how low unemployment would have to fall or whether “qualitative” description would be better.

Some Fed officials said a few numbers as thresholds would confuse investors into thinking the central bank only followed a small number of economic indicators in setting policy.

Some other Fed officials are leery that the public will come to think of any specific number as a “trigger” for Fed action.

Fed officials were also mulling whether to use thresholds to give guidance about the likely path of short-term interest rates after the initial increase.

Economic outlook

In their discussion about the economy, Fed officials were a little more upbeat, saying that a genuine recovery in housing activity appeared to be underway.

The Fed staff revised up its forecast for gross domestic product in both the short-term and medium-run. But with fiscal policy expected to be tight, the staff doesn’t think GDP will grow beyond about 2.4% annual rate. In 2014, activity was expected to accelerate gradually.

Progress on reducing unemployment is expected to be “relatively slow,” the staff said.

The Fed has said it will continue this program in an open-ended manner until the outlook for the labor market improves substantially.

The minutes show that “a couple” of Fed officials wanted to be more explicit about what a substantial improvement in labor markets would look like.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.